Hedge funds place bets, small investor takes fall

The global credit crisis that began last summer, triggered by a collapse in the U.S. market for subprime or "junk" residential mortgages, has since Feb. 15 forced hedge funds with assets of more than $5.4 billion (U.S.) to dump assets at firesale prices or simply liquidate altogether.

The banks now find that those takeover targets, bought at the top of the market and loaded with debt to finance their own acquisition, are struggling to stay current on their debt as the U.S. economy heads into recession.

Three global lenders alone â Citigroup Inc., Lehman Brothers Holdings Inc. and Goldman Sachs Group Inc. â are stuck with an estimated $130 billion (U.S.) in leveraged-buyout debt that they can't unload for lack of buyers in today's credit-squeezed market.

On Monday, a troubled mortgage investment arm of prominent buyout firm Carlyle Group, which includes Frank McKenna, George H.W. Bush and John Major among its rainmakers, begged its lenders for a moratorium on forced sales of its assets. That same day, U.S. buyout giant Blackstone Group LP reported an 89 per cent plunge in fourth-quarter 2007 profit, to $88 million.

"We are in the midst of a severe financial crisis," conceded Blackstone CEO Steve Schwarzman, arguably the most celebrated master of the buyout universe this decade, who now has no idea where we are in the market's fear-exuberance cycle. "How long will it last? I am not certain," Schwarzman said. "No one knows the answer."

Schwarzman took billions of dollars off the table when Blackstone went public at the very peak of the buyout mania last June. Blackstone shares have since lost more than half their value, and it's the same story at prominent buyout firms Apollo Management LP (down 48 per cent), Fortress Investment Group (down 40 per cent) and Oaktree Capital Management LP (down 40 per cent).

Earlier this week, Dutch hedge fund operator GO Capital Asset Management, with assets of $881 million (U.S.) invested in a motley collection of European biotech firms, aircraft propeller engine makers and an Amsterdam car dealership, abruptly suspended fund redemptions, blocking the exits by which investors who haven't already fled might have followed suit.

"Current market circumstances do not allow the fund to sell investments at a reasonable price," GO explained. Translation: there are no buyers at any price.

"They're staring into the jaws of hell," Martin Fridson, an expert on junk bonds, told The New York Times Monday of the deal-makers' plight.

If only that were true. The deal-makers got away clean with their upfront deal-closing fees, and stuck the global banking system with over-leveraged companies and other assets they can't unload. And it will get worse.

The massive subprime writeoffs by global banks won't end until 2009, merely the start of a cascading of debt failure, with recession-induced defaults on prosaic credit-card, auto-loan and other consumer credit next on tap, followed by defaults by companies subjected to over-leveraged buyouts.

The legacy, as if we needed reminding, is that in eras marked by an abundance of easy money, any deal-maker can, for a while, look like a genius. Too bad it's ordinary investors and employees of ruined, over-leveraged companies who get stuck with the mess.